The Cost of Defaulting
When economic headwinds turn it pays to be aware of the consequences of failing to settle a property purchase, warns Shane Campbell.
31 August 2022
By signing an agreement, and declaring all conditions to be fulfilled, a purchaser is committing to a legally binding and enforceable obligation.
That obligation is always a serious one, but is particularly serious when economic headwinds turn and purchasers’ ability to settle becomes impaired by rising interest rates and bank stress testing, CCCFA changes, inflation and downward pressure on housing markets. So what happens when a purchaser can no longer settle?
In most cases a purchaser will not immediately try to walk away. Whether a buyer engages or not, if settlement day comes and goes without the purchase being completed, the vendor is able to serve a notice requiring settlement.
And if the notice expires without settlement, the vendor (under the ADLS/ REINZ agreement) can sue for a court order making the purchaser complete and cancel the agreement, keep the deposit, and sue for damages.
This is called specific performance and is only viable where a purchaser has the financial means to complete. If they don’t courts are unlikely to compel the impossible. An action for specific performance (by summary judgment) should always be considered prior to cancelling and suing for damages.
Cancellation And Deposit
A defaulting purchaser forfeits their deposit. As this is often held by the vendor’s lawyer, it’s theirs as of right. After retaining the deposit a vendor is also entitled to sue the purchaser for any shortfall between the original sale price and the price achieved on re-sale.
In the above scenario the $200,000 deposit paid allowed the vendor a claim of $420,500 against the defaulting purchaser, made up of the loss on re-sale between first and second sale, and costs incurred.
Generally, a party who is suing another party for damages is required to take reasonable steps to reduce the amount of loss suffered.
In the context of a default claim, the duty to mitigate is usually fulfilled by employing a method of re-sale that obtains the best price available for the property in the current market.
Many purchasers, particularly developers, will use a special purpose vehicle in the form of a company to purchase land to isolate the development from other developments and in an endeavour to isolate the directors from personal liability. Often these companies will hold no other assets.
A company has separate legal personality. That usually means when you contract with a company any recourse is against it and not the shareholders or directors, subject to directors adhering to their duties. The most obvious claim against a director (or directors) in this context is a claim under section 36 of the Companies Act 1993.
The ultimate question will be whether the director(s) had “reasonable grounds” to believe, at the time of entering the purchase transaction, the company couldn’t fulfil that obligation. Questions for directors are whether they had finance for the transaction, what their debt limits were, and if they had finance approved on what terms compared to settlement terms.
Settlement defaults create issues for purchasers and vendors. The purchaser will forgo any deposit paid and can be pursued further. Vendors have contractual rights available, however those rights will take time and cost to enforce and the settlement default will likely hamper plans.
Parties should take legal advice before signing a contract and will definitely need specialised advice should a party default on its obligations.